Red Reef: Lowered land values offer most attractive entry point ‘in nearly a decade’

Suzanne Petrela’s experience in agriculture spans over $750 million of equity investments through her work with the Ospraie Special Opportunities Fund, Soros Fund Management, and most recently with the private investment firm she founded in 2009, Red Reef.

At Red Reef, Petrela builds and manages customized farmland portfolios for institutional and ultra-high-net-worth investors. Below, she offers Agri Investor her thoughts on these investors’ views on farmland investments and the current outlook for North American farmland.

How do high-net-worth individuals and family offices differ in their approach to farmland investing compared with institutional investors like pensions and endowments?

All investors we work with are focused on generating strong risk-adjusted returns, and the portfolio benefits of inflation protection and non-correlation. But family offices thinking about intergenerational wealth transfer seem to value farmland more as a long-term inflation hedge as part of a strategic, defensive allocation.

For some institutional investors, allocating to farmland involves navigating return targets set by their boards. An endowment manager once said to me, ‘I wish I had an allocation for farmland, the institution will be here for hundreds of years and we need to position for this, but my incentives are tied to generating at least a 15 percent IRR.’ Well, historically, returns on US row crop farms are more like 10-12 percent. These are highly intelligent allocators who appreciate the investment case but are sometimes working within these parameters.

Family offices seem less concerned about hard hurdles, perfectly timing their market entry, or generating current cash flow, which some institutions need to meet current costs. This can influence the types of assets they buy – for example, fully stabilized farms, versus optimization plays with a better overall return profile. Flexibility is an advantage in building a high quality portfolio because it allows investors to capture better returns and respond more effectively to windows of opportunity. The farmland market is still relatively fragmented and opaque – most farms change hands quickly, quietly, and locally, and it can be difficult to scale at the right times unless you already have a foothold in regions you want exposure to.

What kind of returns are family office investors expecting from farmland?

Many of them are looking for a mid-single digit current cash flow return, with some upside from asset level improvements. With capital appreciation, they expect a total return in the low teens, depending on lease structure, region and what they’re growing.

Are reputational risk concerns different for high-net-worth-family offices, and how does that impact their investments?

We actually don’t hear much concern about reputational risk. Financial investors are established sources of capital for operations, expansion and succession planning in the farm economy. But some family offices and institutions alike are sensitive to the optics of their involvement simply because they are highly visible. For example, family offices of celebrities, business leaders, or philanthropists, and institutional investors that have transparent disclosure policies or are “opinion leaders” closely followed by industry peers.

In our experience, being highly visible doesn’t fundamentally affect how they approach the market because they conduct themselves very professionally. But on a substantive level, there are legitimate sensitivities of people involved in financing and managing our food system, and investors need to appreciate that. Right now, for example, we are seeing some difficult situations where borrowers need to recapitalize, and resolving those situations successfully may require a different approach compared to distressed investing in other areas of the economy.

How have low commodities prices impacted North American farmland values?

Overall, land values haven’t fully expressed the serious deterioration in cashflow we’ve seen with lower crop prices. Part of the story here is a lag effect that’s still playing out. Part of it is that persistent demand and ongoing scarcity of high quality land, plus solid structural demand for certain crops, cushion the decline in values we’d expect based purely on cashflow.

We are long-term value investors and care a lot about political stability, water availability, and strong logistics and management.  Large parts of North America have all these, and are cost-competitive sources of commodities with fairly inelastic demand and structural tailwinds from global growth, rising protein consumption, and renewable energy. They tend to remain viable through prolonged cyclical downturns.

But it’s been hard for us to invest at reasonable values in some of these regions until recently. We are now focused on certain areas of the US where land prices declined because too much debt on top of low crop prices can’t be sustained. We expect to see more recapitalizations before land values stabilize, creating what may be the most attractive entry point we’ve seen in nearly a decade. These situations allow us to get involved as part of a solution and invest at more reasonable levels, ideally in partnership with solid managers who pay down debt and continue farming those lands, so we can support both their immediate needs and longer-term goals.